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How does a health savings account (HSA) work?

A health savings account is a tax-advantaged personal savings account that works in combination with an HSA-qualified high-deductible health insurance policy to provide both an investment and health coverage.

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Key takeaways

Q. How does a health savings account work?

A. Would you like the ability to pay for medical expenses with pre-tax money? What about the option to build retirement savings that can be used at any time – without taxes or penalties – to pay medical expenses that arise along the way? Do you prefer health insurance coverage that comes with a higher deductible and lower premiums?

A health savings account (HSA) could be just what the doctor ordered. Used wisely, this innovative approach to health coverage may provide major advantages that could keep both your personal and financial life healthy.

What is a health savings account?

A health savings account is a tax-advantaged personal savings account that works in combination with an HSA-qualified high-deductible health insurance policy (HDHP) to provide both an investment and health coverage.

The savings account provides the funds you use to pay medical expenses that aren’t paid by your HDHP, or — if you don’t need to use it — is an interest-bearing nest egg that grows over time. The HDHP, meanwhile, is your safety net should you need coverage for major medical expenses that exceed the amount of your deductible. And as long as your HDHP isn’t grandfathered, it’s also required to cover certain preventive care at no cost to you, regardless of whether you’ve met your deductible.

open enrollment 2021

Our 2022 Open Enrollment Guide: Everything you need to know to enroll in an affordable individual-market health plan.

Sounds too good to be true? Well, remember that you’re paying a lower premium for your insurance coverage because it’s a high-deductible plan that doesn’t cover anything other than preventive care before the deductible. If you need to see the doctor for anything else, you’ll pay the entire bill (reduced according to the negotiated rates your health plan has with the doctor) if you haven’t yet met your deductible.

Contributions to your HSA

Opening an HSA allows you to pay lower federal income taxes by making tax-free deposits into your account each year. Most states — all but California and New Jersey — also offer tax breaks on funds deposited in these accounts (some states have no income tax, so HSA contributions would only affect federal taxes in those states).

Contributions can be made by the individual or owns the account or by an employer, or by anyone else who wants to contribute on behalf of the account owner. When people contribute their own funds to an HSA, they don’t have to pay income tax on those funds. The money is either payroll deducted pre-tax (which means it’s free from income tax and FICA taxes), or deducted from your income tax on your tax return (you can deduct your contributions even if you take the standard deduction and don’t itemize). And if an employer contributes, the money is not taxed as income for the employee.

You can no longer contribute to an HSA once you’re enrolled in Medicare — even if, for example, you continue to work and have HDHP coverage from an employer, in addition to Medicare. But as described below, you can continue to withdraw tax-free funds from your HSA after you’re enrolled in Medicare, as long as you use the money to cover out-of-pocket medical expenses, including Medicare premiums.

The 2021 contribution limit is $3,600 if you have individual coverage under your HDHP, and $7,200 if your HDHP also covers at least one other family member. If you have HDHP coverage in 2021 (even if it’s just in December), you have until April 15, 2022 to contribute to your HSA for 2021 (note that the deadlines were extended for 2019 and 2020 contributions, due to COVID; normally, it’s April 15 of the following year, or the tax filing deadline if slightly different).

For 2022, the contribution limit is $3,650 if your HDHP covers just yourself, and $7,300 if you have family HDHP coverage.

If you’re 55 or older, you can contribute an extra $1,000 a year (this is officially called an “additional contribution” and often referred to as a catch-up contribution). This amount isn’t indexed; it stays steady at $1,000 per year. And it’s important to understand that if two spouses are each 55+, they each need their own HSA in order to be able to make a catch-up contribution for each spouse. HSAs are individually owned, rather than jointly owned (they’re like IRAs in that regard). So although a couple might have family HDHP coverage and make the full family HSA contribution to one HSA each year, the HSA is actually in the name of just one spouse. So the catch-up contribution for that spouse can be made to the existing HSA (bringing the 2021 maximum contribution amount to a total of $8,200 for the couple, for example). But the other spouse will need to also open an HSA in order to deposit the other $1,000 catch-up contribution. This is explained in IRS Publication 969.

As of the 2018 tax year, the IRS shortened the main 1040 and moved things that used to be on the main form onto a series of schedules instead. So while you’ll still use Form 8889 to report your HSA contributions and withdrawals, the HSA contribution deduction (if you’re eligible for it) on Form 1040 now shows up on Schedule 1. But nothing has changed about eligibility for the deduction itself. Assuming you make after-tax HSA contributions (ie, not through a payroll deduction, since those are already pre-tax), you’ll get to deduct them on your 1040 and avoid paying income taxes on the amount you contributed.


Withdrawals from your HSA

The money you deposit into your HSA is yours to withdraw at any time to pay for medical expenses that aren’t paid by your high-deductible health insurance policy or reimbursed by anyone else (so if you have a dental policy that pays part of your dental costs, for example, you can only use your HSA funds to pay the portion of your dental bill that you have to pay out-of-pocket). HSAs are considered part of consumer-driven health care (CDHC), meaning that you control the plan, deciding how to spend and invest those dollars.

Expenses may include deductibles, copayments, coinsurance, vision and dental care, and other out-of-pocket medical costs. And the range of services that qualify is broad: You can use your HSA to pay for acupuncture, chiropractor services, or even traditional Chinese medicine (everything you can use it for is outlined in IRS Publication 502). From 2011 through 2019, individuals were not able to use tax-advantaged money from an HSA for over-the-counter drugs that were not prescribed by a doctor. But that changed in 2020 due to the CARES Act, which also changed the rules to allow HSA funds to be used to purchase menstrual products.

You can withdraw the funds at the time you incur the medical expense, or at any point in the future, as long as you had already established the HSA when the expense was incurred. You need to keep careful records either way, but if you’re planning to wait ten years to reimburse yourself for a medical expense, the onus is on you to prove that you had the expense and paid for it out-of-pocket, with non-HSA funds, and saved the receipts.

Can I use my health savings account to pay for my spouse’s medical expenses?

Yes. You use the account to pay for the medical expenses of a spouse or other family members even if they aren’t covered by your HDHP.

Family members include dependent children or qualifying relatives. In other words, it’s anyone who is a part of your tax household – even if they aren’t covered by your HDHP.

If you’re fortunate enough to not need to withdraw from the account to pay for medical expenses, your funds roll over from year to year and your account continues to grow (including investment returns or interest, depending on where you deposit your HSA funds).

Although HSAs provide an excellent way to pay for medical expenses with tax-free funds (and to allow those funds to grow tax-free over many years or decades), withdrawals that are used for anything other than medical expenses are subject to income tax as well as a 20% penalty.

But that penalty is eliminated once you reach age 65. At that point, there is no longer a penalty for withdrawing HSA funds and using them on non-medical expenses. You will, however, pay income tax on those funds. But you can continue to use your HSA funds entirely tax-free after age 65, as long as you only withdraw money to cover qualified out-of-pocket medical expenses. And once you’re 65 and enrolled in Medicare, you can use your HSA funds to pay Medicare premiums for Part B, Part D, and Part C (Medicare Advantage).

(Medigap premiums are not considered an eligible HSA expense, so tax-free HSA funds cannot be used to pay them. And non-Medicare premiums are generally never an expense that can be covered with tax-free HSA funds, unless you’re receiving unemployment benefits or covered under COBRA. All of this is clarified in IRS Publication 969.)

How much can I contribute to my health savings account?

The 2021 contribution limits for HSAs are $3,600 if you have individual coverage, and $7,200 if you have family coverage under an HDHP (family coverage means that your plan covers at least one other family member, in addition to yourself; you don’t have to have your entire family on the plan in order to qualify for the family HSA contribution limit). For people with HDHP coverage in 2022, these limits will increase to $3,650 and $7,300, respectively.

HSA-qualified plans (HDHPs) have deductibles that must be at least $1,400 for singles and $2,800 for families in 2021. These amounts will be unchanged for 2022 (note that insurers can still increase deductibles from 2021 to 2022, despite the fact that the minimum allowable deductibles will not increase).

In addition to minimum deductible requirements, HDHPs have also always had limits on how high the maximum out-of-pocket can be — unlike the rest of the market, which didn’t have limitations like that until 2014 when the bulk of the ACA was implemented. For 2021, as has been the case since 2015, the maximum out-of-pocket limits for HSA qualified plans is lower than the maximum out-of-pocket established for all plans under the ACA. For HSA-qualified plans in 2021, it’s $7,000 for individuals and $14,000 for families, as opposed to the general market rules that limit out-of-pocket spending to $8,550 for individuals and $17,100 for families. For 2022, the maximum allowable out-of-pocket limit for HDHPs will be $7,050 for an individual and $14,100 for a family (as opposed to non-HDHP limits of $8,700 for an individual and $17,400 for a family).

HDHPs are only allowed to cover preventive care before the minimum deductible is met. So an HDHP does not refer to just any health plan with a high deductible. It has to also ensure that the enrollee is responsible for all non-preventive care costs until they’ve met a deductible that’s at least as much as the minimum HDHP deductible set by the IRS. So for example, a plan with a $5,000 individual deductible is not an HDHP if it also covers office visits with just a copay before the deductible is met. But the IRS has added some flexibility in terms of what counts as preventive care, and is also allowing HDHPs to cover COVID-19 testing and treatment before the deductible.

Health savings accounts get mixed reviews

The country is largely split over the question of whether health savings accounts are a wise coverage solution on a large scale – and whether HSAs help or hurt the nation’s health care system.

Proponents of HSAs argue that people tend to be more careful with their own health care costs when they’re paying part of the bills themselves. So instead of going to a doctor for every cough, cut, or cramp, HSA users would have an incentive to be less wasteful with their health care spending, and maybe even take the time to shop around.

They say that the cumulative effect will be a nation of health consumers whose behavior would lower health care costs, while injecting price and quality competition into the medical marketplace. And tax advantages, they say, could lure the uninsured into lower-cost, high-deductible plans, reducing the ranks of the uninsured and possibly even nudging them into healthier lifestyles.

Critics of HSAs argue that health savings accounts benefit the young and healthy, while those with regular medical problems or who are older may end up paying more if they select an HDHP/HSA combination, because they tend to drain their savings with more frequent up-front medical expenses.

But this would be true of any comparison between higher-deductible plans (generally favored by healthier people) and lower-deductible plans. And it’s also worth noting that people with very high-cost medical needs sometimes end up better off with an HDHP/HSA combination, because the tax savings from the HSA and the lower premiums for the HDHP are enough to more than offset the higher deductible (and “high deductible” is becoming a bit of a misnomer, since overall deductibles have been rising fairly rapidly, resulting in HDHPs with deductibles that are often comparable to or even lower than the deductibles on non-HDHPs).

Another argument is that the tax-advantaged option constitutes a tax shelter for the rich, and that low-income families don’t earn enough to benefit from the tax breaks. Further, skeptics warn that many people with HSA plans — and especially the poor — might be reluctant to spend money from their savings account, even on necessary healthcare expenses. Although a reduction in spending on unnecessary care would be beneficial, it’s often hard for a consumer to know what care is necessary and what’s unnecessary, and skimping on the former could lead to higher-cost problems later.

But it’s worth noting that the ACA requires all plans — including HSA-qualified plans — to cover certain preventive care with no cost-sharing. And the IRS issued guidance in 2013 in order to bring HDHP rules income compliance with the ACA’s requirements. So all HSA-qualified plans (effective January 2014 or later) cover the full range of recommended preventive care before the deductible.

How do I set up a health savings account?

Enrollees can choose from a long list of banks, credit unions, and brokerage firms that offer accounts for saving and growing HSA funds.

Enrollment in HSA-qualified HDHPs had soared to 21.8 million people by 2017, up from 10 million people in 2010 (more than three-quarters had HDHP coverage provided by a large employer as of 2017). According to data from America’s Health Insurance Plans (AHIP), enrollment has been growing at a rate of about 15% per year since 2011. AHIP’s data indicates that 8 million individuals were enrolled in HSAs in 2009 and just 3.2 million in 2006 (note that HSAs first became available in 2004). Not all of those enrollees contribute funds to an HSA, but they’re eligible to do so if they want.

Many businesses, large and small, offer these HDHP policies to their employees, but you can also purchase them on your own through the exchange in your state or directly from a health insurance carrier. For people who buy their own insurance, HDHPs are available in nearly every county in the US. If you’re shopping on HealthCare.gov or a state-run marketplace, the HSA-eligible plans will be designated with an icon or a small notification. You’ll be able to use a search filter to narrow the plan selections to only show HSA-eligible plans.

HSA funds: Where should you keep them?

Health insurance companies and employers will generally recommend a bank that insureds can use to establish an HSA once they’re enrolled in an HDHP, but enrollees are free to select any HSA custodian they like.

If you’re enrolling in an HSA through your employer, you’ll likely need to use the HSA custodian that your employer selects in order to have your pre-tax contributions payroll deducted and in order to receive any contributions that your employer makes on your behalf. But once the funds are in your account, you’re free to transfer them to another HSA custodian if you choose to do so.

A long list of banks, credit unions, and brokerage firms offer accounts for saving and growing HSA funds over time, so shop around before you select an HSA custodian. The saving accounts include a dizzying array of options. And brokerages offer countless stocks, bonds, and funds to invest in with low trading fees, while others may have limited choices, are more expensive, and have hidden fees (HSA Search is a useful tool showing fees charged by hundreds of HSA custodians, but it is by no means an exhaustive list of all the available HSA custodians; check with your bank, credit union, or brokerage firm to see what they offer as far as HSAs, and what fees they charge).


Louise Norris is an individual health insurance broker who has been writing about health insurance and health reform since 2006. She has written dozens of opinions and educational pieces about the Affordable Care Act for healthinsurance.org. Her state health exchange updates are regularly cited by media who cover health reform and by other health insurance experts.

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